ECON 1202 1st Edition Lecture 16 Outline of Lecture 15 (Economic Growth (continued)/Framework of Aggregate Demand and Supply)I. Investment-Savings (I=S) LinkII. Market for Loanable Funds: Mirror to Primary Bond MarketIII. Impact of Higher interest RatesIV. Aggregate Demand and Aggregate Supply ModelV. Basic IdeaVI. What does the Model look like?VII. Aggregate DemandVIII. Real Wealth EffectOutline of Lecture 16 (Framework of Aggregate Demand and Supply (continued)) I. Interest Rate EffectII. International Trade EffectIII. What Constitutes Aggregate Demand?IV. Shifts in Aggregate DemandV. What Causes the Components of Aggregate Demand to Change?VI. Why Do We Care About It?VII. AD Shifts: Changes in Foreign VariablesVIII. “Strong Dollar Slams Profits”IX. A Big Shift in Aggregate Demand: The Great DepressionX. Shifts in the AD Curve vs. Movements Along ItXI. Aggregate SupplyXII. Long-Run Aggregate Supply Curve (LRAS)XIII. QuestionsXIV. LRAS ShiftsFramework of Aggregate Demand and Supply (continued)I. Interest Rate Effecta. Decrease in price leveli. Decrease in the interest rateii. Increase spending on investment goodsiii. Increase in the demand for goods and servicesb. Increase in price leveli. Increase in the interest rateii. Decrease spending on investment goodsiii. Decrease in the demand for goods and servicesII. International Trade Effecta. Decrease in domestic price leveli. Domestic prices fall relative to foreign pricesii. Stimulates net exportsb. Increase in domestic price leveli. Domestic prices rise relative to foreign pricesii. Stimulates net imports/less net exportsIII. What Constitutes Aggregate Demand?a. Y=C+I+G+NXb. Total Income=Total Expenditurec. Total Expenditure=Total or Aggregate Demandd. AD=C+I+G+NXIV. Shifts in Aggregate Demanda. Changes in:i. Consumption (C)ii. Investment (I)iii. Government Purchases (G)iv. Changes in Net Exports (NX)V. What Causes the Components of Aggregate Demand to Change?a. Income/Wealthb. Expectations (income, wealth, profitability)i. Ex: an increase in households’ expectations of their future incomes shifts the aggregate demand curve to the right because consumption spending increasesc. Tax Policiesd. Exchange Ratese. Fiscal and Monetary Policyf. Foreign IncomeVI. Why Do We Care About It?a. Recession in Europe=NXi. Exchange rate movements 1. The dollar has appreciated relative to the eurob. Tax Policies on Investment=Ic. Employment Growth=CVII. AD Shifts: Changes in Foreign Variablesa. If foreign incomes rise more slowly than ours, their imports of our goods fall; if ours rise more slowly, our imports fallb. If our exchange rate (the value of the U.S. dollar) rises, our exports become more expensive so foreigners buy less of them and we buy more importsi. Ex: an increase in the exchange rate relative to foreign currencies shifts the aggregate demand curve to the left because imports willrise and exports will fall, reducing net exportsVIII. “Strong Dollar Slams Profits”a. What is happening?i. The dollar is up 27% relative to the euro from last year (12% since January)b. How does that impact U.S. exporters?i. Two considerations:1. Goods prices in euros2. Goods priced in dollarsii. Puts European companies in a much better situationIX. A Big Shift in Aggregate Demand: The Great Depressiona. Early 1930s was the largest drop in real GDPb. Cause was a decrease in aggregate demandi. C and I decreasedX. Shifts of the AD Curve vs. Movements Along Ita. The aggregate demand curve shows the relationship between the price level and real GDP demanded holding everything else constantb. A change in the price level not caused by a component of real GDP changing results in a movement along the AD curvec. A change in some component of aggregate demand will shift the AD curveXI. Aggregate Supplya. Short-run vs. Long-runi. Long-Run AS: potential GDP (“real” factors-land, labor, human capital, physical capital, technology, institutions)1. Aggregate supply curve is vertical 2. Price level doesn’t affect the long-run determinants of GDPa. Supplies of labor, capital, and natural resourcesb. Available technologyii. Short-Run AS: real factors plus inflexible/rigid structure of nominalprices and costs1. Aggregate supply curve is upward slopingXII. Long-Run Aggregate Supply Curve (LRAS)a. Natural Rate of Outputi. Production of goods and services that an economy achieves in the long run1. When unemployment is at its natural rate of unemploymentii. Potential outputiii. Full-employment outputb. In the long run, the level of real GDP is determined by the number of workers, the level of technology, the capital stock, and institutional framework XIII. Questionsa. Why don’t changes in the overall price level impact the output of a nation’s goods and services?b. What is it saying?c. Were there prices on the axes of the PPC?d. Why not?i. Answer: 1. Overall prices have no impact on the overall production of goods and services in the long run2. A nation’s ability to produce “stuff” is a function of L, N, NR, K, HC, E, Tech, Instthe real side of an economyXIV. LRAS Shiftsa. Any change in potential GDP:i. Laborii. Natural Resourcesiii. Institutional Structureiv. Capitalv.